The Hindu Business Line : Inflation targeting goes popular

Hard to believe but a fact. No less than 21 central banks around the world follow an inflation target-based interest rate policy. The well-known examples are the ECB (which also has money supply targets), Bank of England and Reserve Bank of Australia.

But who would have thought Peru, Colombia and Thailand would be up to it? They are and what is more an increasing number, including the big daddy of them all, the US Federal Reserve, are thinking of following suit. That several developing countries are votaries of rule-based monetary policy does come as a surprise.

After all, they have generally been considered immune to the sage advice of the IMF and World Bank on the necessity of `sound' economic management, revolving around the twin pillars of a strong inflation control bias on the part of the central bank and balanced government budgets.

Why then have they succumbed to the attraction of price goals, which restrict choice in the conduct of monetary policy?

Third World growth

The answer must lie in the remarkable acceleration of Third World growth in recent years, thanks to falling trade barriers and the globalisation of product, service and financial markets. Growth is the best antidote to economic indiscipline. (It also has the potential to convert populist politicians to a new faith.

Witness the transformation of the Indian Railways and the hosannas being sung in praise of Bihar as the next investment destination, after a change in the mindset of its rulers. Doesn't it prove nothing is beyond hope?)

With growth and its benefits reaching the poor, the need for safety nets from governments has clearly shrunk. This obviously improves the degrees of freedom of central banks and emboldens them and governments to pursue aggressive inflation goals.

Even as the Bretton Woods twins have been reduced to irrelevance in the new economic order in which financial capital moves seamlessly across borders, their earlier homilies are finding echoes in the emerging market economies. Nevertheless, inflation targeting is hardly on the agenda of the Federal Open Market Committee (FOMC), as it meets on October 23 and 24 to decide on interest rates.

Monetary rules

Mr Alan Greenspan, the previous Chairman of the Fed, thinks the American economy is too complex to be managed with simple monetary rules. It certainly seems the Fed is some distance and time away from price goal-driven policy, despite its current Chairman, Mr Ben Bernanke, being a believer and an advocate. He has been noticeably silent on the issue in recent times.

The overwhelming consensus is for the FOMC to stay pat on interest rates in the current meeting. `Neither growth nor inflation is dead' is the latest conclusion of the Fed's economists. That means we are in for at least a brief phase of no change in rates.

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